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1
Pyramiding scheme: Planning
memorandum for an examination:
The Art of the Interview
As a law enforcement professional that has enjoyed a career in the investigative field, I have arduously pursued
furthering my knowledge and skills by staying current. I therefore found myself preparing for a conference I
was attending in New York City whose primary subject was the detection of fraud. In anticipation, I
elected to query a Report of Investigation, Case No. OIG-509: the Executive Summary by the US Securities
and Exchange Commission, Office of Inspector General.
In my report I will share and conduct a virtual interview and provide a self-developed and useful
interview technique, an investigative tool. Essentially, I intend to determine what occurred, what was
corroborated, what lessons were learned and add to the methodology of an investigator. As well, I wish to
determine if the upcoming conference addressing Domestic and International Markets might somehow
enhance the application or utility of the Bernard Madoff’s Ponzi Scheme-Public Version report.1
My
interest were especially heightened by my participation in the NYCFE conference of the former IG of the
S.E. C, H. David Kotz, the investigator who conducted the examination of failure(s) of the SEC.
I had not previously read the publicized report, I had read media reports and been exposed to the
extensive video coverage of the Madoff debacle. On this occasion, I wanted to drill down, engage in my
own review; examine the available documents and reports to develop a better knowledge of the subject
matter.
In my interpretation of the Madoff examination, I considered the abominable behavior by all the
stakeholders; the series of denials or missed opportunities by many; the dismissive actions of the Agency
which border on malfeasance; the practiced continuity or subscription to a confederation and consequential
employment of inexperienced or mediocre investigators, coupled with the protracted time period-16-years
The impact of the Madoff debacle has arguably triggered a sea-level change to the allusion
of deregulation or function of an oversight commission. In particular, the Executive Summary of
the Investigation of failures of the SEC to uncover Bernard Madoff’s scheme presents a template of
circumstances one should consider when conducting (an investigation) securities examinations and in my view applicable to most fraud reviews.
Consider how much damage a smooth talking swindler is capable of; ponder how available and identified investigative resources can assist in your forecast to project and assess a business practice using financial LEVERAGE; the Madoff debacle can be compared to a cataclysmic weather event similar to the recent widest tornado recorded in modern history at 2.6 miles in diameter, which left behind a trail of destruction 16.2 miles long; a climate change. Concurrently, consider what was learned with the Madoff examination; auditors were not skeptical enough. “Audits are not designed to detect fraud.”
2 Given that I
was conducting a review in the “wrap up phase,” I wanted to determine how the Madoff experience might help mitigate a reoccurrence of such an event; especially, considering the magnitude and frequency of somewhat previous similar events; such as the TYCO
3, ENRON
4 and WORLDCOM
5 6implosions: What
Ten Things did we not learn, specifically, from the Enron Scandal? 7
Could what was uncovered in any of the three referenced implosions compare to what was learned with the Bernard Madoff debacle?
Drawing upon the cultivated lessons and collective experiences of my investigative work; including
document examination, auditing methods and interviewing; I stepped a little out of my comfort zone.
Unlike the investigations I had ever conducted, this was a securities examination; not Credit Card Fraud,
Mortgage fraud, ID Theft or the takeover of an Annuity or other financial account. Subsequently, and
having reviewed the Madoff/SEC Investigation Report, I developed a better appreciation of the
circumstances and facts outlined in the report, delineating the incredible lack of imagination or know how of
the examiners involved. The Madoff Investigation report percolated with acts of deception, manipulation
and theft. Similar to the skilled occasional behavior of Insurance Brokers, Agents and Adjusters involved
with catastrophic property claims; their actions appear to be more a coordinated synergetic and vertiginous
convergence of personalities and relationships, a malevolence of sorts.
The SEC examination was more akin to an audit of the Insurance entities-Third Party
Adjuster/Administrator or Managing General Agent. Where an organization’s operational practices and
procedures are reviewed, evaluated and assessed for risks. Subsequently, the need to determine if what
happened involved more an actual series of missed opportunities or if consequences v. designed outcome
became a consideration; Evaluating and establishing practices and behavior of facilitators of the fund
while cross checking facts which could be substantiated, beyond circumstance, giving rise to a scheme
more akin to a strategy or paradigm? Review of the practices and outcome of the SEC examination fell
squarely in the heart of fraternity, affiliation, influence- perdition of sorts by a trusted captain of industry-
the unraveling of OZ.
In the pantheon of great investigators I have been privileged to know, I celebrate the fortuitous
knowledge imparted to me by Rita R. Harfield, CPCU (Chartered Property Casualty Underwriter8). It
was during a summary review of findings and observations where the behavior of a person of interest, a
potential subject’s experience, a Broker, a trusted business partner, prompted an evaluation of their skill
set, their experience and most notable their responses. In this context it was an acknowledged experience
over many years that was significant, “but was it the first year over many times” pondered Rita? That is,
was it thirty years’ experience or was it one year’s experience repeated over thirty times. The premise
was confounding.
3
Many a learned lesson would weigh heavily on what I had come to now understand as a watershed
Moment ! The implication of a distinguishable culpability, beyond a reasonable doubt, where comparison
to a poor business plan or a mistake in judgment or carelessness was unsustainable. Essentially, the
elements of this investigation like the many before identified a known actor engaged in deceit, bolstered
by representations known to be false or fraudulent.
Madoff’s behavior was not dissimilar to criminal fraud scenarios where establishing or disproving
the requisite behavior of deceit includes substantiating something of value was obtained during the course
of the deception.
A lot of the transactions involved purported to have involved trades and the exchange of
commodities. Independently checking the accuracy or reliability of the fund’s performance was a
fundamental task. What was puzzling was the skepticism of the investigators. It struck me as a just
criticism where reluctance appears to have set in; a kind of additional review was discouraged-something
in line with-“My arms are too short to box with God.”
I. (Assessment)
Admittedly, I commenced the task of stepping into an area of assessment within my knowledge
base, yet beyond my experience; I had not performed a securities examination: Yet a groundswell of
knowledge sustained me as I purposely paced myself and digested each syllable, every reference-adhering
to the fundamental lessons gleaned through the investigating process. Given the circumstances were not
exigent, I chose to be deliberate-connect the dots-then try to disprove the facts, placing little reliance on the
spin. I queried resources, utilized my network, and referenced a library of knowledge and experience,
including third parties-cohorts. Soon after, I found myself applying a concept developed over decades of
conducting interviews, or pray tell interrogations. I applied the fundamentals learned and developed; come
to the interview armed with knowledge and project sangfroid. That is not to say; you, one, should have
no interest in the outcome; but be prepared to follow wherever developments lead you.
Keep in mind; I had the enviable position of not having been part of the Agency or Investigative
Commission during the course of the investigation. My interest after all was benign. Independent reading
and education of the facts before attending the conference was my incentive. My instincts and training
prompted me to qualify and quantify.
2
Wisconsin Law Journal, by Tracy L. Coenen, CPA, MBA, CFF; 01/25/06. http://www.sequenceinc.com/why- didnt-our-auditors-find-the-fraud/ 3
TYCO-How cooking the Books Works. http://money.howstuffworks.com/cooking-books10.htm 4
The Enron Scandal: http://voices.yahoo.com/the-enron-scandal-crime-scandal-tragedy-controversy-136695.html 5
Look for the lie. Is there something known by the investigator, yet not being disclosed by the interviewee. Something so overwhelming that should have been done.–seek out the indecision or choice not to resolve the issue straight forward.
A particular comment strikes out from the many observations offered by the contemporary view
provided in the report regarding a financial plans performance v. the market’s performance. As suggested,
the Madoff success in business proffered an unusual outcome, as it purported an “astonishing ability to
time the market and move to cash in the underlying securities before market conditions turn[ed] negative
and the related ability to buy and sell the underlying stocks without noticeably affecting the market.”
[2001 Journal Articles (MAR Hedge by Michael Ocrant and Barron’s by Erin Arvedlund) about Madoff’s
unusually consistent returns] 9
III.
(Due-diligence )
Embedded inside the investigative report was an innocuous remark, yet one which underscores the
denial aspect of my proposition which I feel is strategic to determining an element of fraud, during an
interview, seeking independent verification. As stated by the expert retained by the SEC;
“The most critical step in examining or investigating a potential Ponzi scheme is to verify the
subject’s trading or activities through an independent third party.” 10
But, in my review it was not just the person of interest who demonstrated the requisite behavior, it was the Agency charged with oversight and regulation of security transactions.
IV.
(Lessons learned )
The autopsy of the investigation report suggests, when conducting a cause examination involving
securities11
a team or teams should be assembled having analysis or investigative experience and [should]
include planning for the examination. This is not much different than any credible group performing an
examination. The scopes of the examination should not be narrow in focus but include significant steps
to analyze matters of concern regarding trading and returns. 12
Examiners should look for contradictions
and inconsistencies running down each concern while not accepting verbal explanations alone at face
value.
Inexperienced investigators were repeatedly assigned to conduct separate aspects of allegations
made concerning suspected practices by Madoff. “Red flags and highly unusual fills for equity
trades”… “Misrepresentations of [Madoff’s] unusually consistent, non-volatile returns over
several years” were sited throughout the report. 13
[Avoidance incarnate] Again, it was the
Agency engaged in the prerequisite conduct-almost as if fraudulent conduct of such magnitude
was beyond comprehension.
9 Barron’s, an article by Erin Arvedlund, “Don’t Ask Don’t Tell: Bernie Madoff is so secretive…”May 7
th, 2001. MAR Hedge, an article by Michael
Ocrant, “Madoff tops charts; skeptics ask how,” May 2001.
5
V.
(FORM AN INVESTIGATIVE TEAM; COMPOSED OF INDIVIDUALS WITH ANALYTICAL
ACUMEN: TECHNICAL KNOW HOW; TOOLS; ADMINISTRATIVE COORDINATION AND
LEGAL GUIDE TOTACKLE THE ISSUE:)
Information developed and evaluated should be checked and verified by different team members
and shared within the investigative group. The team should include individuals strong in audit skills, a
CPA is desirable. Absent a CPA a CFE, CFCS is preferred; an individual versed in computer and technical
skills-recent revelations have accented that gangs are using technology such as IP masking, Meta data in
JPGs and phishing techniques; a competent surveillance component and state-of- the-art field equipment-
hardware and software that brings the observations in the field home to the management office; an attorney
versed in the applicable statutes, regulations and compliance factors-; an analyst knowledgeable
in data mining with fundamental skills in excel, access and specifically the public and government
financial reporters (e.g. FinCen) ; an administrative coordinator capable of tracking, indexing and
formatting text, right down to variations in the font, word spacing, grammar and punctuation; and a lead
investigator for each team-an individual grounded in conviction, knowledgeable and not bound to a desk.
The tasks of desk examination can be left to the Director who equally handles the administration duties,
personnel duties, assignment duties.
Each member of the team should know as much of the investigation as possible, each member should be
utilized consistent with their strengths and be cross trained and able to pick up where another team
member leaves off.
Unlike the SECs actions in the Madoff examination- do not rebuff offers of evidence and seek
clarification where confused or unsure of fundamental aspects of operational matter(s) under
investigation. Where an unusual occurrence is determined (e.g.; unusual returns where the majority of
market funds are having a dissimilar experience; or a failure to produce financial statements; or non-
existent outside performance audits30
) such determination should be a cause for concern. Verify all
transactional records reviewed and compare with documents obtained from an independent oversight
entity.
My senses invoke that a lack of fundamental knowledge of yields, comparisons and evaluation of
a suitable stock index by staff was incredible. How else could one qualify performance? However, my
senses alone can arguably be refuted as instinct unsupported by facts. How about the fundamental utility
of a dictionary or glossary of pertinent terms for reference and understanding; development of an
appreciation of norms and anomalies of the particular financial transactions evaluated and reconciled;
development and comparison of a beta set of like securities performance from which findings can be
harnessed and measured throughout the examination and integrated into the review. I couldn’t decide?
Was it some void that had suddenly taken grasp of all tenured local SEC investigators? Was the collective
knowledge and resources of the SEC purged or otherwise engaged? The methodology I mentioned
Before the interview do your due-diligence. Given the interviewer is versed in the subject matter
and has done an examination; collected documentation, performed an analysis and sought
technical and independent support for preliminary findings; the absence of one to interview can
still provide leads, knowledge, data from which an investigative foundation or scope can be
developed. However, if conducting an interview use of a recorder should be considered. Absent
use of a recording device; notes should always be taken.
Personal, medical or questions protected by privilege or sexual orientation should be avoided. A
second interviewer who can record or write responses to question asked or information sought
should be incorporated into the interview process. This individual (the recorder) can also serve
as a witness or buffer where circumstances warrant.
Selecting a venue where to conduct the interview is paramount. Circumstances may warrant
choosing a private place, non-custodial, possibly the interviewee’s residence, an office or other
off-site location. If in a workplace environment; privacy and the discreet selection of a
comfortable and accessible space should be chosen. HR should always be consulted before,
during and after conducting an interview when the person of interest is an employee or
business partner. ***
Timed breaks for water or beverage consumption should be adhered to. Bathroom use or other
personal needs of all involved in the interview should be accommodated and recorded.
In advance of an interview both general and specific questions can be outlined in a cogent order
with emphasis directed at the matter under review. Determine the need for a translator or other
required participant. Do not over schedule or exceed the total number of participants in an
interview beyond three individuals-this can be easily construed as imposing and coercive.
Prior to commencing the interview consider restriction and guidelines annunciated by procedures
of the entity; union or contractual agreements.
Take a witness or interviewees statement when possible. Ask the interviewee or witness if they
are willing to provide a statement and if they agree to include a declaration of said willingness in
their statement. Allow the interviewee to write a statement in their own handwriting, use their
own words, and write their own illustrations. Ask for their signature and endorsement on the
statement-providing for a signature, date and time on each page and margin of the document. All
present during the interview should sign the statement as being present when given.
Overall, contact or unethical behavior directed at the interviewee should NEVER take place. The
use of ploys, trickery or sub-rosa scenarios is not prohibited but should be recognized as not
useful in all circumstances. NEVER force a witness or person of interest to provide a response.
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ALL PARTIES SHOULD BE AWARE THE INTERVIEW IS BEING RECORDED:ii
1. If an interview is to take place the use of a voice recorder or video/voice recorder should be evaluated before the
interview. Regardless of the venue, all participants should be aware the interview is being recorded. Although some states
allow recording during an interview without providing notice, at least twelve states require “two-party consent,” before
recording. At last look twelve states require consent of every party to a phone call or conversation in order to make the
recording lawful.” 27
ONE-PARTY CONSENT V. TWO-PARTY CONSENT:
2. “Federal Law permits recording telephone calls and in person conversations with the consent of at least one of the parties.
See 18 U.S.C. 2511(2)(d). This is called a “one-party consent” law. Under a one-party consent law, you can record a
phone call or conversation so long as you are a party to the conversation. Furthermore, if you are not a party to the
conversation, a “one-party consent” law will allow you to record the conversation or phone call so long as your source consents and has full knowledge that the communication will be recorded. See the State Law: Recording section of
this legal guide for information on state wiretapping laws.” 28
3. Secret audio recording, including wiretapping and eavesdropping may impose liability for recording audio of a
conversation without consent of one or more parties. See Recording Police Officers and Public Officials 29: Recording
Public Meetings and Court Hearings :
4. States in the US requiring Two-Party Consent (*Per Digital Media Law)
Query European, Latin American or other international counterparts where applicable to obtain documentation or verification. Utilize the National Securities Clearing Corporation (NSCC)
Seek copies of brokerage accounts directly from the Depository Trust & Clearing Corporation Company
(DTCC). [The parent serves as a managed accounts service which standardizes the exchange of account
and investment information through one central gateway] has ten subsidiaries and three joint ventures;
Derivatives Repository Ltd-is headquartered in London and regulated by the UK Financial Services
(FSA). The entity is a trade repository which provides a suite of post trade recordkeeping and reporting
services for (OTC) equity, credit and interest rates, derivatives. Coverage is being expanded to include
foreign exchanges.
DTCC Deriv/SERV LLC-1
st and only comprehensive trade database and centralized electronic
infrastructure for post-trade processing of OTC credit derivatives contracts over their lifecycles, from
confirmation through to final settlement. The Warehouse Trust Company LLC, an organization
regulated as member of the Federal Reserve and the New York State Banking Department.
GSD-Government Securities Division of the DTCC
NSCC-National Securities Clearing Corporation
The National Association of Securities Dealers (NASD) should be queried for independent data.
Follow-up on any correspondence sent to FIs where leads suggest negative or inconsistent
responses to claimed utility of an FI by the subject to clear trades, requesting trades done by or on
behalf of a particular subject’s feeder fund.31
Plan the investigation in every facet possible all the
way to the end.
Look for the “exclusive” or “special” fund limited to a set group of investors, with some special
investors getting higher returns than others. Consider examining the possibility of a hidden third-
party relationship, look to disprove lack of correlation to the marketplace through the tracing of
funds.
EDGAR provides a general purpose search which can help to identify several activities or
ongoing developments planned within a public company. Outlined are a few of the ways an
investigator can research such information available via public access. An EDGAR Central
Index Key (CIK) Lookup 32
(CIK) number, Standard Industrial Classification (SIC) code, can
be determined and researched within the database. A CIK is the unique number that the SEC’s
computer system assigns to individuals and corporations who file disclosure documents with the
SEC. All new electronic and paper filers, foreign and domestic, receive a CIK number.
The EDGAR- http://www.sec.gov/edgar.shtml system provides free public access to Public
Companies and operations by outlining registration statements, prospectuses and periodic reports
filed on Form 10-K 33
(Audited annual financial statements), Form 10-Q34
(Unaudited
31 Feeder Fund: A fund that is similar to a FUND OF FUNDS except that virtually all the underling investments
are held by a master fund. Barron’s Dictionary of Finance & Investment Terms, 8th Ed. 32 http://www.sec.gov/edgar/searchedgar/cik.htm 33 http://www.sec.gov/answers/form10k.htm 34 http://www.sec.gov/answers/form10q.htm
Ernesto A. “Pete” Castillo Pete holds both a Master of Arts and a Bachelor of Arts degree in Public Administration. Pete’s professional experience is concentrated in Risk Management and encompasses a career in law enforcement, as a NYPD Detective specializing in fraud investigations while assigned to the New York County District Attorney’s Office; to extensive investigative experience within the insurance and banking industries as an examiner, internal auditor and underwriter. Pete’s has served as an expert witness in the State Court, and summary witness within the Federal court. Pete’s most recent assignment is the Fraud Investigative Analyst, for the Department of Justice, United States Attorney, the Middle District of Florida. Pete holds designations as a Certified Fraud Examiner and a Certified Financial Crime Specialist. Pete is the former President and most recent Chairman of the New York Chapter of the Association of Certified Fraud Examiners (NYCFE).
Disclosure:
The information and narratives provided are based on the experience of the writer and sources referenced. Every effort has been made to carefully demonstrate lawfully useful and accepted best practices. The author makes no representation that this article is all inclusive or encompassing of every fraud malady or risk solution.